Gold Stocks Turning Up

The gold miners have seen impressive investor interest in their beaten-down
stocks in this young new year, with capital inflows fueling a sharp rally.
And this buying is likely just beginning, as major market changes are afoot
that should catapult gold much higher. With gold stocks trading at fundamentally-absurd
price levels relative to prevailing gold prices, this sector's upside potential
is vast and unequalled.

But after the gold miners suffered a miserable couple of years, it sure takes
a contrarian to understand that. The leading gold-stock investment vehicle
and metric is Van Eck Global's Gold Miners ETF, which trades under the symbol
GDX. It is an excellent well-constructed gold-stock
benchmark that matches the traditional HUI gold-stock index very well.
So it naturally reflected the extreme carnage ravaging this sector.

GDX dropped 13.0% in 2014, following 2013's disastrous 54.5% plummet. With
the general stock markets levitating endlessly higher thanks to the Fed's aggressive QE3
campaign and associated jawboning, demand for alternative investments withered.
These are led by gold, which often moves in the opposite direction of the stock
markets. With stocks soaring, investors shunned it and prudent portfolio diversification.

And since gold stocks are ultimately just a leveraged play on gold, their
prices cratered. Investors simply wholesale abandoned them, leaving an entire
sector for dead. As they seemingly perpetually spiraled ever lower, all but
the hardest-core contrarians capitulated and sold. But this extreme selling
created an epic opportunity, as gold-stock prices plunged far below fundamentally-justified
levels based on their profits.

As long as the Fed's stock-market levitation continued, gold and thus its
miners would remain deeply out of favor. But with the inflationist US central
bank ending QE3 late last year and planning the first rate hikes since mid-2006
this year, the Fed has
abandoned these lofty and overvalued stock
markets. As they inevitably roll over without trillions of dollars of
QE liquidity injections, gold will gradually return to favor.

All financial markets are forever cyclical, with periods of outperformance
always following periods of underperformance and vice versa. So smart contrarian
investors are well aware the stock markets are overdue to reverse lower while
gold mean reverts higher. Thus they are starting to buy the dirt-cheap gold
stocks in anticipation of these inevitable major reversals. And that's why
gold stocks are turning up this year.

Institutional investors including pension, mutual, and hedge funds control
the vast majority of capital in the stock markets. And their performance is
judged by current and prospective clients in calendar-year blocks. So as 2014
wound down, few funds wanted to show the despised gold stocks on their trading
books. But 2015 brings an entire new year for gold stocks to rebound higher,
so funds are migrating back in.

This is readily evident in gold-stock technicals, represented here by that
flagship GDX gold-stock ETF. In this young new year's first three trading days,
GDX rocketed 11.4% higher! That nicely leveraged the also-excellent 3.1% gold
rally over that same period. This outstanding gold-stock price action worked
to solidify this sector's nascent uptrend, while triggering a bullish breakout
above GDX's 50-day moving average.

Gold stocks have definitely been trending higher in recent months, defying
the universal bearishness still plaguing this sector. GDX's higher lows and
higher highs have formed this nascent uptrend, which will probably grow into
a major new upleg. This leading gold-stock ETF is already up 23.4% from its
dismal early-November low. And such a strong breakout above its 50dma implies
upside momentum is building.

To understand the significance of all this, some context is essential. After
suffering an extraordinarily anomalous down year in 2013 thanks to the Fed's
stock-market levitation crushing gold demand, the gold stocks spent the large
majority of last year performing quite well. GDX enjoyed a solid consolidation
uptrend between January and September 2014, with uplegs fueled by big-to-massive
gold-futures buying.

The Fed's QE3 goosing the stock markets drove the epically bearish psychology
that fueled the extreme gold and gold-stock selling of the last couple years.
But those gold liquidations largely came from just two groups of traders, American
futures speculators and American shareholders of the flagship GLD gold ETF.
With investors missing in action, the futures traders in particular utterly dominated
gold prices.

So when they covered some shorts and added new long positions in the yellow
metal last January and February and again in June, the gold stocks shot up
dramatically as gold itself recovered. Considering how low and out of favor
gold remained last year, GDX's pair of uplegs averaging 27.5% were certainly
respectable. But unfortunately 2014's consolidation uptrend failed in September on
heavy gold-futures shorting.

That month American speculators got caught up in the frenzied hyper-bearish
gold psychology to ramp up their short positions very aggressively. They borrowed
and sold incredible amounts of gold-futures contracts, pushing their total
shorts to
near-record levels. This extreme and unsustainable selling was finally
exhausted in early November, but it did serious technical damage to gold and
its miners' stocks.

GDX plunged 39.5% in less than several months, totally erasing the minor improvement
in overall gold-stock sentiment generated by 2014's modest uptrend before September.
Facing such a brutal withering onslaught of futures selling, gold dropped 12.6%
over that span. While that's certainly not trivial, GDX more than tripling that
gold selloff was wildly excessive. That reflected prevailing hyper-bearishness.

But short selling is the most bullish kind of selling since it is inherently
self-limiting. Speculators have to effectively borrow gold to sell it
short. And all that borrowed gold must soon be repaid, which means every ounce
sold short has to reverse into buying in the near future. And with speculators'
gold-futures short contracts approaching crazy record levels, these traders
finally reached selling exhaustion in November.

And the resulting gold-stock lows were ridiculous. GDX plunged to $16.59 in
early November, which was almost a record low for this ETF. It only traded
lower for a single day in late October 2008 in the dark heart of that once-in-a-century
stock panic. Gold stocks had almost never been cheaper in GDX terms! And such
price levels were truly fundamentally absurd compared to the prevailing
gold prices.

Throughout the entire stock markets, stock prices ultimately reflect their
core fundamentals which are underlying corporate profits. And in the gold-mining
industry, the dominant driver of earnings is the price of gold. Costs for any
particular mine are largely determined by its deposit, and fixed when that
mine is designed and constructed. So gold-price changes flow directly to the
bottom line, where they're amplified.

Back in October 2008 when GDX briefly plummeted to $16.37 per share, gold
traded at $732. But in early November 2014 when GDX was hammered to $16.59,
gold was $1144. So even though gold's prevailing price was 56.3% higher, GDX
was merely 1.3% higher! It is supremely irrational for the gold stocks to be
trading as if gold was far lower than it really was, as they were far
too cheap relative to their profitability.

This next chart looks at the relationship between gold-stock price levels
and gold as seen through the lens of the GDX/GLD Ratio. Dividing the leading
gold-stock-ETF price by the flagship gold-ETF price, and charting the results
over time, reveals how gold stocks are priced relative to the core fundamental
driver of their earnings. And they had never been more undervalued and
out of favor than late last year!

While gold stocks recently bottomed in early November at that 6-year low,
the GDX/GLD Ratio sunk a little lower at their secondary bottom in mid-December.
The miners' selloff early last month was extremely disproportional to gold's,
forcing the GGR lower. A GDX share was trading at just 0.149x the price of
a GLD share, the lowest levels ever seen in GDX's history. For reference,
this ETF was born back in May 2006.

Even during late 2008's stock panic, which was the most-extreme market fear
event most of us will ever witness in our lifetimes, the GGR merely fell to
0.227x at worst. And that was driven by GDX plummeting a truly nauseating 71.0%
in just a matter of months! How on earth can gold-stock sentiment be worse
in late 2014 after a consolidation year than it was in late 2008 after the
first full-blown stock panic since 1907?

The GGR's stock-panic levels were an extreme anomaly, and such massive deviations
from norms in the markets never last. The epic levels of fear necessary to
force such epic lows soon burn themselves out, then beaten-down prices dramatically
mean revert higher. And indeed over the next several years after 2008's stock
panic, gold-stock prices would more than quadruple. Buying low in extreme
fear pays big.

The contrarian investors moving into gold stocks in early 2015 expect a similar
or better outcome this time around from this sector's even-more-extreme low
in late 2014. If the much-higher stock-panic gold-stock price levels weren't
sustainable, why should today's far-more-extreme levels be? Smart investors
study market history, so they understand that financial markets are forever
cyclical. Great anomalies are short-lived.

And the cycles have never been more overdue to turn for gold stocks, as the
GGR's secular resistance line shows. Gold stocks' performance relative to gold's
is reflected by this key fundamental ratio. When the GGR is rising, gold stocks
are usually rallying faster than gold as they regain investors' favor. But
a falling GGR means the opposite, that gold stocks are losing favor among investors
and dropping faster than gold.

Literally since late 2007, a long secular span of time, gold stocks have been
underperforming gold on balance. Whenever gold retreated during the past 7
years or so, the gold stocks greatly leveraged its downside which forced the
GGR lower. But whenever gold rallied, the gold stocks failed to sufficiently
leverage its gains. So the GGR struggled to regain ground, except for that
year following the stock panic.

No market trend can run forever, including gold-stock price levels relative
to gold. And the longer that any trend runs, the more extreme it gets in price
and sentiment terms, the greater the probabilities of an imminent reversal.
Gold stocks not only can't fall out of favor relative to gold forever, but
they are certain to return to favor in the coming years as the market cycles
shift. There is no surer bet in all the markets.

And that prospect is why contrarian investors started returning to this despised
sector in early 2015. The gold stocks are probably the only super-cheap sector
left in these lofty Fed-inflated stock markets. They are the only one that
has the potential to at least quadruple again in the coming years no
matter what the stock markets do. Their mean reversion higher relative to gold
is way overdue, and it's going to be massive.

The recent GDX/GLD Ratio extreme lows vividly illustrate gold stocks' incredible
upside potential in the coming years. Remember that 2013 and 2014 were extreme
anomalies thanks to the Fed's brazen and reckless manipulations of stock-trader
psychology. So the last normal years in this post-stock-panic era were between
2009 and 2012. Over that span the GGR averaged 0.381x, GDX traded near 3/8ths
GLD's price.

Merely to return to those levels, assuming gold stays flat around today's
$1200, GDX would have to rally 156% higher from its mid-December low!
That would catapult it back up around $44, and as of this week only 1/8th of
that inevitable mean-reversion normalization higher has happened. With gold
stocks pounded to such fundamentally-absurd levels in recent months, their
upside is great even if gold does nothing.

But gold is exceptionally low and out of favor too, so it has massive potential
to mean revert higher itself as the Fed-goosed stock markets roll over and
alternative investments and prudent portfolio diversification gradually return
to favor. Higher gold prices plugged into any GGR naturally portend higher
gold-stock prices as well. For example, consider GLD's price levels in 2012
before the Fed's vast QE3 distortions.

GLD averaged $162 that year, and even that wasn't particularly high since
the yellow metal had just suffered a major correction out of a euphoric
overbought topping in late 2011. If GLD merely returns to those pre-QE3
levels and the GGR simply mean reverts to its 2009-to-2012 normal-year average,
we are looking at a GDX price target near $62! That's 3.1x higher than this
week's levels, another quadruple.

And both gold and the ratio of the stocks of its miners to it should go a
heck of a lot higher. In the post-panic years before gold's correction, the
GGR averaged 0.419x. And the last time gold stocks were remotely close to being
in favor before 2008's stock panic, the GGR averaged 0.591x! So much-higher
numbers can be conservatively plugged into this key fundamental relationship
to yield far-higher GDX targets.

But it gets even more bullish, because mean reversions out of sentiment extremes
never just stop at the previous average levels. Instead they dramatically
overshoot to the other side. Visualize sentiment as a giant pendulum with
two extremes to its arc, universal greed and fear. The farther that pendulum
gets pulled to one side's sentiment extreme before that emotion burns itself
out, the higher the velocity of its back swing.

All that momentum carries the sentiment pendulum to a similar extreme on
the opposite end of its arc. So the odds are excellent that gold stocks
will regain favor to a great-enough degree to temporarily force the GGR up
to very high levels. Thus the upside potential in this left-for-dead sector
is extraordinary. The wealth that's going to be created as gold stocks mean
revert higher and multiply will be life-changing.

The contrarian investors returning to gold stocks in early 2015 certainly
understand that. They realize that the Fed-levitated stock markets are on the
verge of rolling over decisively, which will rekindle gold investment demand.
And as gold itself recovers, the radically-undervalued and wildly-oversold
gold stocks are going to rocket higher. They will very likely be this year's
best-performing sector in all the stock markets.

Another major bullish factor coming into play is the utter collapse in energy
prices. Gold mining is an incredibly energy-intensive industry. It takes vast
amounts of energy to dig up heavy rock, haul it, crush it, and extract the
relatively tiny quantities of gold out of that ore. Energy is often the
largest variable cost for gold miners. So the brutal collapse in energy
prices in recent months is also going to really boost profits.

And that will make gold stocks look even more ludicrously undervalued than
they already do, which is hard to believe. After falling out of favor for so
long, after suffering an unbelievably anomalous year (2013) and its aftermath
(2014), gold stocks are overdue to soar this year. The smart contrarians buying
in early before the rest of the herd starts understanding gold stocks' vast
upside potential are going to earn fortunes.

Why not join them? We can help you at Zeal, as we've spent 15 years now intensely
studying and trading gold and silver stocks. We continue to research this entire
forgotten sector to uncover the elite companies with the best projects and
fundamentals. Periodically we profile our favorite dozen in some sub-sector
in fascinating fundamental reports. Buy
them and get up to speed quick on the best gold stocks!

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The bottom line is gold stocks are already turning higher in this young new
year. Contrarian investors realize they are radically undervalued compared
to the prevailing gold prices that drive their profits. And they are the greatest
bargains in the entire stock markets, the only sector with the potential to
easily at least quadruple in the coming few years while the rest of the Fed-goosed
stock markets stall out and drop.

And the upside potential for the beaten-down gold stocks is extraordinary.
As they inevitably start to return to favor as gold mean reverts higher, the
upside targets are multiples of current price levels. And after such an extreme
stint of bottom-feeding, the resulting mean reversion and overshoot should
be proportionally extreme to the upside. Prudent investors who buy in early
are destined to earn fortunes.

If you have questions I would be more than happy to address
them through my private consulting business. Please visit www.zealllc.com/financial.htm for
more information.

Thoughts, comments, flames, letter-bombs? Fire away at zelotes@zealllc.com.
Due to my staggering and perpetually increasing e-mail load, I regret that
I am not able to respond to comments personally. I WILL read all messages though,
and really appreciate your feedback!

Mr. Hamilton, a private investor and contrarian analyst,
publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis
of markets, geopolitics, economics, finance, and investing delivered from an
explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for
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